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Anticipating a cut by the US Fed, the major currencies, Euro, Pound and Yen have
rallied against the US dollar. The dollar’s slide against other major currencies may
continue for some more time. Other countries and central banks may also react to the
US rate cuts in the next few weeks.
* Prepared by: Rama Krishna V, Equity Analyst, State Bank of Mysore, STB, MUMBAI
vrk_100 @yahoo.co.in Date: Dec.17,2008
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The US Fed has further said that it would buy long-term government bonds. Currently,
US Treasurys are at record high prices. With the decision of the Fed to purchase long-
term bonds, the bond prices may go up so high that the yields might be unattractive for
investors, especially, banks. By buying more government bonds, the US Fed would
make the Treasury yields less attractive for banks so that the banks will be encouraged
to resort to normal commercial lending operations, thereby unfreezing the credit
markets.
The big bailout packages, US Fed rate cuts and other extraordinary measures mean that
the US has been printing more and more dollars for economic revival. More dollars in the
system means more budget deficits. The implication is that long-term bond holders are
taking on considerable risk with their investments in US Government securities at this
point of time. The falling interest rates and the rising US deficits are potential negatives
for the dollar.
Market reaction:
Stock Markets: After the rate cut, the US stock markets have reacted positively to the
news. The benchmark-Dow Jones Industrial Average-index on 16.12.08 had closed at a
level of 8,924, up 360 points or 4.2% from previous day’s close. Whereas, Nasdaq has
closed at 1,590, up 82 points or 5.4% and S&P 500 closed at 913, up 45 points or 5.1%.
Bond Market: The US bond market also has rallied after rate cut. The US Government
bond prices have gone up pushing the yields further down. Yields of some important
Treasurys are given below:
Crude oil market: Crude oil market has not reacted much to the Fed’s decision signifying
that the demand for oil may not see any revival as long as the world economy continues
to be in recession. The Nymex crude oil price is hovering around USD 44 a barrel.
Obviously, the current hypothesis that a weak dollar will push up commodities’ prices is
not proved correct this time. Moreover, OPEC is meeting in Algeria today, i.e.,
December 17, 2008 and it is expected that the organization may agree on an oil output
cut of two million barrels a day. Oil market may be looking for cues from OPEC rather
than from the US Fed’s rate cuts. The decision by the OPEC is expected in the next few
hours.
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